This year’s banking stress tests from the Bank of England will introduce a new element not seen on previous occasions. This year, the stress tests will require the banking industry of the UK to prove that it will be able to withstand another slump in the global economy.
This move comes a few months after the former chief of the bank, Mervyn King, said that the banking system remained weak and may not be able to withstand another financial crisis without improvements first being made.
Bank of England stress testing is a relatively recent concept, dating back to 2013. It is carried out annually, and seeks to assess the strength of the baking system and its potential vulnerabilities by examining it in detail and reporting on its ability to handle various hazards and eventualities. The 2014 stress test looked primarily at vulnerabilities in the banking system that relate to the housing sector.
The parameters of this year’s banking stress tests have been set out by the Bank of England. It will explore a number of eventualities that would relate or potentially lead to another global financial crisis.
For instance, the report will assess the system’s ability to survive should economic growth in the Eurozone suffer a sharp downturn. Major banks and building societies will be required to present evidence that they are in a sufficiently strong and stable position to survive if the Eurozone’s economic output should fall by up to 2%.
The stress tests will also look at how vulnerable the UK banking system would be to a collapse in economic growth in China – one of the world’s most important economies and one to which the UK banking industry has significant exposure. In particular, should China experience economic growth of only 1.7%, Hong Kong would fall into a serious recession. The Hong Kong property sector is an important one for many UK firms including HSBC, and these firms would be hit hard as prices drop by an estimated 40%. As part of this year’s stress tests, banks will have to prove that they would be able to survive should this eventuality come to pass.
Furthermore, the tests will look at what would happen should the UK see serious economic contraction. The Bank of England will assess whether banks could withstand total contraction of 2.3%.
Last year’s tests were considered thorough, so it is a surprise to some that this year the tests seem even stricter. However, this year’s tests will remedy one common criticism of last year’s report – that it focussed solely on the UK and ignored the many international vulnerabilities that UK banks and building societies hold.